WHAT ARE DIVIDENDS? WHY THEY DESERVE A LOOK IN THE MARKET DOWNTURN
The market’s messy start to the year doesn’t appear to be improving any time soon. As we discussed, staying put might be your best strategy. However, diving stock prices might also be a good time to hunt for bargains. Dividend paying stocks can be a great place to start given the reassurance their regular payments give amid the market volatility.
Dividends are cash payments some companies make to their investors, usually once a quarter. Dividends are a company’s way of re-distributing their earnings and cash back to their investors. You can choose to take your dividend as cash, or have it reinvested into additional shares of the company.
Dividend stocks allow you to earn income while you wait for your long-term returns to accumulate. Plus, given the continued low interest rates (the Fed is not raising rates much until inflation moves), dividend stocks will pay you a lot more in income than you would get in bond or cash interest payments.
Here’s the catch – dividend stocks are quite often boring stocks. That’s because exciting, growth stocks don’t usually pay high dividends. Growth stocks (think earlier stage companies like Facebook) either make negative income, or need to use their cash to invest in the company’s growth. More stable stocks, and ones sitting on large cash piles, tend to be the ones that can distribute their cash out to shareholders.
But in this market, you don’t want to invest in anything too exciting (aka “risky”). You want to minimize losses and maximize returns while you wait for the market to rebound. Dividend stocks can help you do that – and studies show they tend to outperform the market with less volatility.
When it comes to picking a dividend stock, you don’t just want to blindly pick the stocks with the highest dividend yields. In fact, if the dividend yield is too high, it could indicate that the company is paying dividends it can’t afford or that it is not growing at all.
The key is to find stocks that offer both dividends and some potential for future growth. Ideally this company would also raise dividends as its performance grows. Here are some stocks that may be worth considering in that category (yields as of market close 1/28):
- NRG Energy (NRG) – 5.86% dividend yield
- AT&T (T) – 5.41% dividend yield
- HollyFrontier Corp (HFC) – 4.01%
- Coca-Cola (KO) – 3.14% dividend yield
- Apple (AAPL) – 2.23% dividend yield
[Note: a dividend yield is the annual dividends paid divided by the current price of the stock. in other words, it’s your one year return if the stock price doesn’t move.]
Two caveats to note. From a tax perspective, ordinary dividends are taxed at the same rate as your income. This is unlike long-term capital gains taxes (for gains on stocks held for more than a year), which are taxed at the current capital gains rate of up to 15% (certain qualified dividends however are taxed at the capital gains rate too).
Additionally, while certain companies may have consistently paid dividends in the past, there can be no assurance or guarantee that they will be able to continue paying dividends in the future.